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Inflation
Inflation is part of the IB syllabus for macroeconomics . It is also part of the AP Macroeconomics syllabus for Economic Basics, Measurement of Economic Performance, and Inflation, Unemployment and Stabilization Policies Definition Inflation Inflation is the rise in the general level of prices of goods and services in an economy. This does not mean that ALL prices levels are rising though. Some will shoot up, others will slowly rise and some don't change at all. Inflation is to much money chasing to few goods. Deflation Deflation, appropriately is the complete opposite. It is the decline in the economy's price levels on goods and services. It is when annual inflation falls below zero percent. This will allow you to buy more goods with the same amount of money. People will believe they have more purchasing power. Costs of Inflation and Deflation When Inflation occurs the money value will decrease in the economy. With the money value decreasing the people will seem to be poorer than before and that will cause consumption to decrease. As consumption decreases AD will also decrease because consumption is a component of AD. When deflation occurs the opposite happens. The money value will increase and that will make the people seem to be richer than before, causing consuption to increase and therefore AD to also increase. Anticipated inflation: "If I see inflation rising, I act differently!" A lender anticipates inflation by trying to build into interest rate, accounting for inflation, but end up getting hurt because of unanticipated inflation; the borrower is helped. Unanticipated inflation: Some people will benefit from the people that think "If I see inflation rising, I act differently!" Causes of Inflation Cost/Supply Push Cost push inflation occurs when the price of a staple good (such as oil) increases. Input costs are a determinant of supply, so as the cost of a staple good increases, the supply curve shifts to the left, thus raising prices. This price increase phenomenom occurs on an aggregate level with the short-run aggregate supply shifting to the left. Inflation ensues. Demand Pull When AD increases, quantity produced and price level temporarily increase (point 1'''). However, since only a set amount of production can be reached in the long run, quantity supplied must eventually return to equilibrium. This is reflected by the stationary LRAS curve--if businesses were able to produce more goods, LRAS would shift to the right. Since AD has increased, the new equilibrium will be at the same quantity but a higher price level. (point '''2). This process may repeat itself and drive price levels higher if AD continues to increase. Excess monetary growth Methods of Measuring Inflation *One way to measure inflation is to calculate an inflation rate of the Consumer Price Index. By comparing data of the value of goods/services that people would buy between two different years/time periods, one can find a percentage change that can be then designated as the inflation rate (based on the CPI). *Another way to measure inflation is to utilize the GDP deflator. The GDP deflator measures the prices of goods and services in the Gross Domestic Product. By dividing the nominal GDP by real GDP, one can calculate a percentage much like the CPI inflation rate, and find an inflation rate based on the nominal/real values of GDP. Problems of the Methods of Measuring Inflation Inflation is measured by using a weighted basket of goods and looking at the changes in price. However, there are many difficulties in the measuring of inflation that can lead to inaccurate results. A single price change does represent general inflation in an overall economy. The combined price is the sum of the weighted average prices of items in the "basket". A weighted price is calculated by multiplying the unit price of an item to the number of those items the average consumer purchases. Weighted pricing is a necessary means to measuring the impact of individual unit price changes on the economy's overall inflation. The Consumer Price Index uses data collected by surveying households to determine what proportion of the typical consumer's overall spending is spent on specific goods and services, and weights the average prices of those items accordingly. Those weighted average prices are then combined to calculate the overall price. There are issues in the measurement of inflation with this basket though. It will not account for changes in the quality of a good, just its price. Furthermore, the weighting is very subjective and technically everyone's inflation is slightly different. Phillip's Curve The Phillips curve is a curve that originally showed the inverse relationship between wage inflation and unemployment. Now it more often shows the relationship between price inflation and unemployment. Unemployment is considered high or low relative to the natural rate of unemployment. Inflation is considered high and low relative to the expected inflation rate. Below is a graph of the Phillips Curve The Long Run Phillips curve shows the relationship between unemployment rate and inflation in the long run. It is also the natural rate of unemployment. The natural rate of employment is the rate of unemployment at which inflation is equal to the expected inflation.The long run Phillip's curve will always have the same unemployment rate for any rate of inflation. Therefore it is a vertical line.